Before you move on to Bollinger bands formula, here is a bit about it,
Bollinger bands are a technical analysis tool that consists of a simple moving average (SMA) and two bands drawn above and below the SMA. The bands are calculated as a function of the standard deviation of the data being plotted. The purpose of Bollinger bands is to provide a relative definition of high and low prices of a security. By definition, prices are high at the upper band and low at the lower band. The bands are self-adjusting: as prices fluctuate, the bands widen and narrow.
The formula for calculating Bollinger bands is as follows:
Upper Bollinger Band = SMA + (2 * standard deviation) Lower Bollinger Band = SMA – (2 * standard deviation)
Where:
- SMA is the simple moving average
- standard deviation is a measure of the dispersion of a data set from its mean
For example, if you want to calculate Bollinger bands for a stock using a 20-day SMA and 2 standard deviations, you would first need to calculate the 20-day SMA for the stock. Then, you would need to calculate the standard deviation of the stock’s prices over the same 20-day period. Finally, you would use the SMA and standard deviation values to calculate the upper and lower Bollinger bands as shown in the formula above.
Bollinger bands can be used to identify trends and patterns, as well as to set up trades. For example, if the price of a stock is consistently touching or crossing the upper Bollinger band, it may be considered overbought and ripe for a sell trade. Conversely, if the price is consistently touching or crossing the lower Bollinger band, it may be considered oversold and ripe for a buy trade.
Read: Rally base drop strategy
Important points to note for Bollinger bands
There are a few additional points that may be useful to know about Bollinger bands once you are done with Bollinger bands formula:
- The default setting for Bollinger bands is a 20-day SMA and 2 standard deviations. However, you can use different time periods and standard deviation values to suit your needs. Some traders may use a shorter time period and a higher standard deviation to capture more short-term price movements, while others may use a longer time period and a lower standard deviation to capture longer-term trends.
- Bollinger bands are best used in conjunction with other technical indicators. For example, you might use Bollinger bands to identify overbought or oversold conditions, and then confirm these signals with another indicator such as the relative strength index (RSI) or the moving average convergence divergence (MACD) indicator.
- Bollinger bands are most effective when the price is trending. In a ranging market, the bands may contract and expand frequently, which can make it difficult to trade using Bollinger bands alone.
- Bollinger bands can be used on any financial market, including stocks, commodities, forex, and cryptocurrencies.
